This recent WSJ article titled, "The Risk of Safety", is annoying. First, they suggest avoiding the Vanguard Total Bond Market Index Fund. Their justification is the risk rising of interest rates. They suggest instead of investing in the Vanguard Total Bond Market Index, investors should switch to the Vanguard Short-Term Bond ETF, which has a shorter duration and a 1.6% yield. Is the author deliberately misleading people or just lousy at giving advice ? If the entire premise of avoiding the Vanguard Total Bond Market Fund is that it's future is risky and we should not rely on it's previous performance, then why mislead readers by advising them to jump into Vanguard Short-Term Bond ETF using the prior 12 month returns of 1.6%.If he's so concerned about future rates, he should not use the funds TTM (trailing twelve months) return.The Short-Term Bond ETF current SEC yield of 0.53% is the less "risky" indicator.

For a very short horizon, say a few years, or the typical attention span of investors, I tend to agree with them. People are largely incapable of properly buying and holding mutual funds. Total bond works well, even in a lost decade, because if you hold it you are buying more shares at a lower price. (Although I would question the tax efficiency of this.) But it does not work when people sell it at the worst times.

The author isn't misleading people. Shorter duration bond funds will not drop as much when interest rates rise because the bonds will mature much faster. The longer the duration, the more susceptible it is to decline when/if interest rates rise.

And in all honesty, I find the title "The risk of safety" to be on the mark. Bond funds have experienced excellent TOTAL RETURNS for the past ~30 years because they started out with very high interest rates and as rates have come down the prices/NAVs have risen. With only so much room to go down further, it looks like the return for the next few years will be from interest alone.

If you're getting 2% annually and inflation is running at 2%, and you have little prospects of price appreciation, you are treading water. Too frequently people confuse nominal gains with real gains. Just because the dollar amount rises does not mean you have gained anything in purchasing power.

I feel like this is good advise. I avoided this ETF for the same concerns. Long term bonds have interest rate risk that I didn't need, or want in my portfolio. I choose both short, and intermediate term bond ETF instead. If I was younger, I might not concern myself with this risk, but at my age, the bond portion of my investments, is to stabilize the investment portfolio.If I'd have owned this fund for long period, I'd have kept it with my written plan. But I didn't, and sure wouldn't buy into it at this point.

At the Very Least, Work Hard, Do Your Best, Know the Truth and the Facts and Always Be Honest!

Here is another 3-month growth-of chart for the same funds as in the chart I previously posted:

All the funds had a negative total-return over the 3-months. I don't recall so much gnashing of teeth a couple years ago about all this, so I expect I won't recall any of this next year at this time either.

NYBoglehead wrote:The author isn't misleading people. Shorter duration bond funds will not drop as much when interest rates rise because the bonds will mature much faster. The longer the duration, the more susceptible it is to decline when/if interest rates rise.

And in all honesty, I find the title "The risk of safety" to be on the mark. Bond funds have experienced excellent TOTAL RETURNS for the past ~30 years because they started out with very high interest rates and as rates have come down the prices/NAVs have risen. With only so much room to go down further, it looks like the return for the next few years will be from interest alone.

If you're getting 2% annually and inflation is running at 2%, and you have little prospects of price appreciation, you are treading water. Too frequently people confuse nominal gains with real gains. Just because the dollar amount rises does not mean you have gained anything in purchasing power.

Well it's still better than "Money Under Mattress' where you are losing 2%, and better than Stocks where you could lose 50% or more.

So, what do you recommend for the Bond portion of a portfolio, if not bonds?

Bustoff wrote:This recent WSJ article titled, "The Risk of Safety", is annoying. First, they suggest avoiding the Vanguard Total Bond Market Index Fund. Their justification is the risk rising of interest rates. They suggest instead of investing in the Vanguard Total Bond Market Index, investors should switch to the Vanguard Short-Term Bond ETF, which has a shorter duration and a 1.6% yield.

I didn't read the link - perhaps the author improperly said "Yield" instead of "Distribution Yield." Although, even Distribution Yield dropped from 1.80% in July 2011 to 1.29% in January 2013.

Anyhow, suggesting Vanguard ST Bond IF based on need for the money..... no problem, man!

I could not read the article, no subscription, and google points me at the same link. What ETF are they suggesting? Vanguard has many short term bond ETFs. Does the short term corporate, VCSH, make sense if one already owns VFSUX, the short term investment grade actively managed fund? BSV is the ETF version of VBIRX short term index, so no need to use an ETF for that. In general, I am not a fan of bond ETFs. Their monthly dividends are slower to reinvest than that of open ended mutual funds.

By the looks of the chart a few posts up, we've seen interest rates rise a bit and bond prices fall. This would be problematic for someone who needs to liquidate their portfolio in a matter of weeks or months and has allocated everything to longer-dated bonds. But that should never happen.

Instead, long-term investors should start with a diversified equity allocation and dilute the risk according to their needs and preferences by adding high quality bonds. And then realize, neither stocks nor bonds always go up. The goal is to have your bonds holding value or appreciating when stocks are declining, while allowing for bonds to disappoint during strong periods for equities. The last 3 months is a great example of this: disappointing returns for bonds but a spike for stocks as a balanced US equity split (20% S&P 500, 30% US large value, 50% mid/small value) has appreciated by almost 11%, or over 50% on an annualized basis. With a balanced portfolio somewhere between 50% and 70% in stocks, this gain more than offsets a setback in bonds.

It is important to always consider the whole picture, because salesman (brokers selling high cost bond separate accounts or tactical management schemes to quell investor fears about bonds) and the financial media will do whatever it takes to get you to focus on the trees instead of the forest.

EDN wrote:By the looks of the chart a few posts up, we've seen interest rates rise a bit and bond prices fall. This would be problematic for someone who needs to liquidate their portfolio in a matter of weeks or months and has allocated everything to longer-dated bonds. But that should never happen.

Instead, long-term investors should start with a diversified equity allocation and dilute the risk according to their needs and preferences by adding high quality bonds. And then realize, neither stocks nor bonds always go up. The goal is to have your bonds holding value or appreciating when stocks are declining, while allowing for bonds to disappoint during strong periods for equities. The last 3 months is a great example of this: disappointing returns for bonds but a spike for stocks as a balanced US equity split (20% S&P 500, 30% US large value, 50% mid/small value) has appreciated by almost 11%, or over 50% on an annualized basis. With a balanced portfolio somewhere between 50% and 70% in stocks, this gain more than offsets a setback in bonds.

It is important to always consider the whole picture, because salesman (brokers selling high cost bond separate accounts to quell investor fears about bonds) and the financial media will do whatever it takes to get you to focus on the trees instead of the forest.

Eric

This advice is nuts because it presumes people invest with a thoughtful long term plan. Our interest is trying to figure out how everything we buy can be protected from the critical crises of the day, any one of which could cost us everything in an instant.

I know some folks regard CD ladders as stuff for grandmas and grandpas, however, a CD ladder might be one thing to consider. It's one thing to think intellectually about duration, points of indifference, yield curves, etc. It's another, I guess, to actually see your bond fund holding(s) flat-line (or, gasp, go down) for a few months. Maybe longer.

Last edited by john94549 on Sun Jan 27, 2013 11:20 am, edited 1 time in total.

dbr wrote: This advice is nuts because it presumes people invest with a thoughtful long term plan. Our interest is trying to figure out how everything we buy can be protected from the critical crises of the day, any one of which could cost us everything in an instant.

I'm not quite sure what your point is here.

If you have a 60/40 portfolio and you want to rebalance into a 50% overnight drop in the equity market you only need 30% of you original FI portfolio to get you back to your 60/40 AA. That means only 30% of your FI portfolio in very low risk FI like short Treasuries and the other 70% to chase yield if thats what you want to do.

You don't have to have all of your FI in one pot. Diversify.

A scientist looks for THE answer to a problem, an engineer looks for AN answer. Investing is not a science.

am wrote:If your only goal is to dampen the volatility of a 60/40 portfolio, why not just use short term bond ETF, especially in the current environment? How much in return would you really give up?

Exactly my thinking FWIW. Interest rates on intermediate bonds are so low, cutting them to zero has a negligible effect on my overall return, especially on an after-tax basis. I just don't see a sufficient reward to undertake the risk - but then, I haven't for some time, during which bond investors have eked out those gains while I haven't.

I've asked bond investors to consider a thought experiment wherein the yield on the 10-year treasury was X%, where X is some arbitrary low number. The question I pose is: is there no rate below which you'd reconsider your allocation to that asset? Suppose it dropped to 1% i.e. Japanese levels. Suppose it's 0.1%. Is there not any rate at which you'd throw in the towel? If you cannot imagine a rate at which you'd stand down, I submit to you that you are being dogmatic. But if there's some level where you'd exit, then can you say why? After all, that absurdly low rate is a "market" rate, right? My answer FWIW: below 2-3% there is, for me, insufficient return to cover the opportunity cost of locking up the cash for that time period.

Last edited by dmcmahon on Sun Jan 27, 2013 11:27 am, edited 1 time in total.

Thanks, your link worked. The answer to my question about what Vanguard ETF was recommended instead of Total Bond Index was BSV. VBIRX would be the mutual fund version and I would use that, if I were following their advice which I am not.

Last edited by SpringMan on Sun Jan 27, 2013 11:22 am, edited 1 time in total.

Thanks, your linked worked. The answer to my question about what Vanguard ETF was recommended instead of Total Bond Index was BSV. VBIRX would be the mutual fund version and I would use that, if I were following their advice which I am not.

+1 Agree

"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

dbr wrote: This advice is nuts because it presumes people invest with a thoughtful long term plan. Our interest is trying to figure out how everything we buy can be protected from the critical crises of the day, any one of which could cost us everything in an instant.

I'm not quite sure what your point is here.

If you have a 60/40 portfolio and you want to rebalance into a 50% overnight drop in the equity market you only need 30% of you original FI portfolio to get you back to your 60/40 AA. That means only 30% of your FI portfolio in very low risk FI like short Treasuries and the other 70% to chase yield if thats what you want to do.

You don't have to have all of your FI in one pot. Diversify.

I think dbr was being funny. Hopefully I'm right. Or maybe he was just reflecting on his 100x's leveraged investments aka long term capital management style investing.

Showing up at the donut shop at 5 am to get them hot out of the oil is an example of successful market timing.

ofcmetz wrote: I think dbr was being funny. Hopefully I'm right. Or maybe he was just reflecting on his 100x's leveraged investments aka long term capital management style investing.

I thought he was being funny also. It was just a good foil to emphasize that all you FI does not need to go into one pot and that it really takes a lot less FI to rebalance than a quick look might indicate.

A scientist looks for THE answer to a problem, an engineer looks for AN answer. Investing is not a science.

ofcmetz wrote: I think dbr was being funny. Hopefully I'm right. Or maybe he was just reflecting on his 100x's leveraged investments aka long term capital management style investing.

I thought he was being funny also. It was just a good foil to emphasize that all you FI does not need to go into one pot and that it really takes a lot less FI to rebalance than a quick look might indicate.

I don't think it is funny at all when people abandon well thought out long term plans that make sense based on investment fundamentals to chase every worry, panic, trend, guess, headline, etc. in making investment decisions.

I don't think it is funny at all when people abandon well thought out long term plans that make sense based on investment fundamentals to chase every worry, panic, trend, guess, headline, etc. in making investment decisions.

EDN wrote:By the looks of the chart a few posts up, we've seen interest rates rise a bit and bond prices fall. This would be problematic for someone who needs to liquidate their portfolio in a matter of weeks or months and has allocated everything to longer-dated bonds. But that should never happen.

Instead, long-term investors should start with a diversified equity allocation and dilute the risk according to their needs and preferences by adding high quality bonds. And then realize, neither stocks nor bonds always go up. The goal is to have your bonds holding value or appreciating when stocks are declining, while allowing for bonds to disappoint during strong periods for equities. The last 3 months is a great example of this: disappointing returns for bonds but a spike for stocks as a balanced US equity split (20% S&P 500, 30% US large value, 50% mid/small value) has appreciated by almost 11%, or over 50% on an annualized basis. With a balanced portfolio somewhere between 50% and 70% in stocks, this gain more than offsets a setback in bonds.

It is important to always consider the whole picture, because salesman (brokers selling high cost bond separate accounts to quell investor fears about bonds) and the financial media will do whatever it takes to get you to focus on the trees instead of the forest.

Eric

This advice is nuts because it presumes people invest with a thoughtful long term plan. Our interest is trying to figure out how everything we buy can be protected from the critical crises of the day, any one of which could cost us everything in an instant.

Doc in response to dbr wrote:I'm not quite sure what your point is here.

dbr wrote:Obviously I am fully in support of the the post by Eric (EDN).

Doc

I guess that "nuts" was in reference to the "well thought out plan". That "well thought out plan" with regard to FI seems to come down to invest in TBM and diversified equities. The problem is that so many people think that you don't need to diversify FI in more than one fund because VBMFX happens to hold some 15000 different securities.

I think we may be having a problem with English rather than investing philosophy. Maybe we should switch to "bond speak".

Doc wrote:I guess that "nuts" was in reference to the "well thought out plan". That "well thought out plan" with regard to FI seems to come down to invest in TBM and diversified equities. The problem is that so many people think that you don't need to diversify FI in more than one fund because VBMFX happens to hold some 15000 different securities.

I think we may be having a problem with English rather than investing philosophy. Maybe we should switch to "bond speak".

It's all about having a rational, fundamentally based long term plan and not making investment decisions based on panic about some current condition or another.

I couldn't care less exactly what bonds people think they should invest in. There are just a very few really stupid things one might do in bonds, and those don't come up here, mostly.

My resolution for today is that from now on I am not participating in any threads on bonds.

I don't think it is funny at all when people abandon well thought out long term plans that make sense based on investment fundamentals to chase every worry, panic, trend, guess, headline, etc. in making investment decisions.

Obviously I am fully in support of the the post by Eric (EDN).

Bogleheads:

I am fully in support of the post by Eric AND the post by DBR.

Best wishes.Taylor

I am in fully in support of Eric and DBR but, Taylor, aren't you the advocate of the three fund, keep it simple, portfolio which uses TBM FI fund which it seem that Eric, DBR (maybe) and I are questioning?

dbr wrote:It's all about having a rational, fundamentally based long term plan and not making investment decisions based on panic about some current condition or another.

I agree. The question is does a single TBM fund meet that objective? I think not and I think Eric agrees.

If a single TBM fund was that "rational, fundamentally based long term plan" we would have a lot fewer of these bond threads.

A scientist looks for THE answer to a problem, an engineer looks for AN answer. Investing is not a science.

Very strange, it works now, but not earlier. I first followed the OP link and couldn't access w/o subscription. So I googled, and the first link was the story, but the link took me to same subscription block.

I wonder if it takes a while before the google link accesses a sub-free version?

When I set up the portfolio in 2007, I decided on 50/50 aggregate bond and stable-value, specifically so I wouldn't have to think about bonds. A central tenet of my investing philosophy is that I don't know enough to market time anything.

livesoft wrote:Here is another 3-month growth-of chart for the same funds as in the chart I previously posted:

All the funds had a negative total-return over the 3-months.

The same referenced chart shows Vanguard's Corporate VWEAX returning 3.23% over the same short 3 month time frame. VWEAX has been a FI diversifier that has been helpful for over a decade. Will it continue? Are the spreads becoming too thin to continue holding? Is it a suitable choice for other investors? Where is Carnac the Magnificent when we need him?

Bradley

You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”

livesoft wrote:Here is another 3-month growth-of chart for the same funds as in the chart I previously posted:

All the funds had a negative total-return over the 3-months.

The same referenced chart shows Vanguard's Corporate VWEAX returning 3.23% over the same short 3 month time frame. VWEAX has been a FI diversifier that has been helpful for over a decade. Will it continue? Are the spreads becoming too thin to continue holding? Is it a suitable choice for other investors? Where is Carnac the Magnificent when we need him?

Bradley

That is almost 70% less than a diversified portfolio of US stocks* (+11%) and about 50% less than a 60/40 mix of that diversified stock portfolio and high-quality bonds** (+6.5%). For the risk (HY was -20%+ in 2008, more than the 60/40 decline), that ain't so hot.

Eric

*20% S&P 500, 30% US large value, 50% US small value** 12% S&P 500, 18% US large value, 30% US small value, 40% Int'd Government

I don't think it is funny at all when people abandon well thought out long term plans that make sense based on investment fundamentals to chase every worry, panic, trend, guess, headline, etc. in making investment decisions.

Obviously I am fully in support of the the post by Eric (EDN).

Bogleheads:

I am fully in support of the post by Eric AND the post by DBR.

Best wishes.Taylor

I am in fully in support of Eric and DBR but, Taylor, aren't you the advocate of the three fund, keep it simple, portfolio which uses TBM FI fund which it seem that Eric, DBR (maybe) and I are questioning?

dbr wrote:It's all about having a rational, fundamentally based long term plan and not making investment decisions based on panic about some current condition or another.

I agree. The question is does a single TBM fund meet that objective? I think not and I think Eric agrees.

If a single TBM fund was that "rational, fundamentally based long term plan" we would have a lot fewer of these bond threads.

If I can understand this recent back-and-forth, the question is if everyone should have everything in TBM?

My answer would be no, but I'm not sure there is a single bond holding everyone should have everything in. TBM is good (about 5yr maturity, relatively high quality holdings) and will work well for many--clearly it is the default choice for a "total market" allocation. Some prefer less interest rate risk (and will opt for ST Bond Index), others prefer less credit risk (and will opt for Int'd Government funds), still others want/need more protection from unexpected inflation (will use TIPS).

With bonds, it's easier to discuss what almost no one should own: below investment grade bonds, preferred stocks, convertible bonds, any bonds of long-term maturity.

And, of course, no one should be altering their bond allocation based on media chatter or crystal ball gazing about the future of interest rates or credit spreads unless you hold a fund that is employing some sort of disciplined "variable" maturity or credit approach (under which case you aren't making changes, the fund is).

I don't think it is funny at all when people abandon well thought out long term plans that make sense based on investment fundamentals to chase every worry, panic, trend, guess, headline, etc. in making investment decisions.

Obviously I am fully in support of the the post by Eric (EDN).

I wrote:

I am fully in support of the post by Eric AND the post by DBR.

Doc wrote:

Taylor, aren't you the advocate of the three fund, keep it simple, portfolio which uses TBM FI fund which it seem that Eric, DBR (maybe) and I are questioning?

Doc: I was agreeing with the above quote by DBR which is not "funny." It is fundamental to the Boglehead Philosophy of stay-the-course.

If investors think that adding additional bond funds to already diversified Total Bond Market Index Fund is worth the complexity, they could be right (or wrong). I don't know.

Anecdotal evidence and colloquialisms aside, is there any real evidence to support the notion that there is a significant advantage to diversifying FI beyond Total Bond Fund ? From what I've read on this forum and in the two Boglehead books, I got the impression that the TBM was a perfectly safe port for all storms.